Central Banks worldwide are scrambling to modernize their payments infrastructure, and one particular model is taking off. We at Swipe had the opportunity to develop a Proof of Concept (POC) of such a system for the Central Bank of Brazil, in which we used Distributed Ledger Technology (DLT, the tech behind Blockchain) to build a structure which, in our view, is a good demonstration of how money should be transferred in the digital era.
Payments for the digital age
Payment systems are evolving at an increasing pace. Looming on the horizon are new technologies and business models which, in just a few years, are expected to drastically change how we make our everyday transfers and purchases. Chief among these innovations are Fast Payments: payments which are authorized and settled in real time, available 24/7, and typically require nothing more than a mobile app and a QR code.
Here’s why all eyes in the financial industry are set on this trend and, since you’re reading this, why you probably should also be aware:
1. Fast Payments are likely to replace other payment methods in the near future.
Credit cards, despite being able to provide authorization in real time, usually take at least 1 workday to settle the transaction and relay the amount to merchants. In countries such as Brazil, however, it is a common business practice to settle in as long as 30 days. Fast Payments promise to solve that gap by authorizing and settling in real time.
Furthermore, if we step out of retail and take a look at use cases like transfers between accounts, there are even larger gaps which need to be filled. Methods such as bank transfers, on top of not being available out of workdays and business hours, may charge expensive fees, lack instant confirmation of the transaction, and typically require the payer to fill out as much as 5 different pieces of information to identify the receiver.
Besides being — as it says on the tin — faster and available 24/7, Fast Payments are meant to be easy to use, being readily available to anyone on their mobile devices. At the receiver’s side, accepting these payments can be as simple as setting up an ID, registering your mobile number and printing out a QR code, which is much less expensive for merchants compared to debit cards.
It is no wonder that practically every use case you can think of, from peer-to-peer transfers to both online and on-site retail, stands to benefit from its adoption.
2. Fast Payments have the potential to fundamentally disrupt current payment schemes.
Usually, the infrastructure for Fast Payments is set and maintained by the central monetary authority itself, such as a central bank. Therefore, this arrangement does away with the established role of a payment network such as Visa and Mastercard, which nowadays serves to connect merchant acquirers and sets its own terms, conditions and fees.
With Fast Payments, any payment service provider (PSP) can connect directly to a nationwide network and make transfers between accounts held by any other PSP on the network. Less parties in the payment chain means less fees that are passed along to end-users, and, as a result, the central bank is free to develop an ecosystem that is both more competitive for PSPs and less costly for every party involved.
3. Both of these breakthroughs are already happening.
In 2016, the Reserve Bank of India launched the Universal Payments Interface (UPI), a prime example of a national Fast Payments system which has since spurred other countries to explore similar models. Since its introduction, user adoption has grown steadily towards a total of 674 mn transactions being processed in February 2019, putting India on track to become less and less cash-dependent, as well as making a dent on Mastercard and Visa’s market share.
Central banks from other countries have also deployed their own implementations. Australia’s New Payment Platform launched in February 2018, and currently has 52 mn account holders making 80 mn transactions worth over $65 bn. Singapore’s FAST interbank transfer system launched in 2014, opened up to accept non-banks as PSPs in 2018 and completed 4 mn transactions valued at $7.3 bn in December 2017. The United Kingdom’s Faster Payments Service has been active since 2008 (although its design does not provide real-time settlement) and processed 176 mn transactions in February 2019. The European Union’s TIPS system was launched in November 2018, and the United States has assembled a task force to develop its own infrastructure.
The case of Brazil
Brazil is one of the many countries looking to develop and implement its own Fast Payments system. In May 2018, the Central Bank of Brazil established a work group in which market players such as banks, payment processors and fintech companies submitted suggestions for the structure and guidelines of the future Brazilian Fast Payments system, which is expected to roll out by March 2021.
Around the same time, the Central Bank announced the opening of LIFT, a fintech innovation lab which gathered startups, entrepreneurs and established companies to develop projects to improve the National Financial System. Swipe took part in the program and developed a POC for a Brazilian Fast Payments system.
The following is a summary of our project, in which we show the general design and results of the POC. The full technical report is available here in Portuguese.
Our approach to Fast Payments
Swipe is a Brazilian fintech startup that enables money and any asset to be transferred digitally in real time. Our solution streamlines the basic elements every financial application uses — assets, accounts and transfers — while using a DLT-based back end to provide end-to-end transaction tracking and history, consistency of balances, and an overall increase in efficiency for both startups and established companies.
Being specialized in DLT, we knew of the Central Bank of Brazil’s research on DLT, as well as projects such as Ubin, Jasper, Stella and Khokha, in which other Central Banks experimented using DLT to build more efficient settlement mechanisms. Moreover, the Central Bank’s announcements on the Fast Payments ecosystem presented a preview of the structure listing its essential features, and two points stood out to us as something our DLT-based solution would be suitable: it was necessary to build a settlement infrastructure that transfers funds instantly and a connecting hub — a “Switch” — that allows any PSP to transfer to any other PSP in the network.
With that in mind, we set as the goal of our project to make prototypes of a Real-time Settlement Module, a Switch, and a simple Digital Wallet we could use to demonstrate the payment flow.
At the time, the Central Bank proposed a structure for the ecosystem that can be summarized by the following schematic:
In order to participate in the ecosystem, each PSP (or another PSP on their behalf) has to pre-fund a Settlement Account held by the Central Bank. Whenever a user orders a payment on a PSP’s platform, transactions are routed via Switch to other PSPs, and are then authorized and settled by the Real-time Settlement Module. As defined at that time by the Central Bank, in order to be considered real-time, this entire interaction has to happen in under 20 seconds.
For the Real-time Settlement Module, our design was centered on our Swipe Network, a permissioned DLT network built on top of the Stellar protocol. Stellar is an open network whose average processing rate of 1,000 transactions per second and settlement speed of 5 seconds we found very attractive for this use case. We chose to use a permissioned version of the Stellar Network in order to better ensure user privacy, as well as to make scalability tests with full control over settings and hardware.
To act as a Switch, we used our Swipe API, which streamlines integration to the network and adds layers of security and privacy.
Finally, we developed a Digital Wallet:
After designing each component, we performed tests to measure the prototype’s performance regarding speed and scalability. Our results: our system proved capable of processing and settling transactions consistently in 5.8 seconds and reaching 105 transactions per second, which equals the historical high of daily bank transfers in Brazil today. Take a look at a demo:
Since then, we have continuously improved our system, and at the time of writing this, we have upgraded our figures tenfold, having reached a consistent average of 1,100 transactions per second with an authorization time of 0.5 seconds.
The use of a DLT network in this project provides end-to-end tracking of every transaction, which can be paramount from the standpoint of a public entity seeking to prevent fraud and other financial crimes. But perhaps the highest value of this approach is that it essentially enables the Central Bank to issue its own digital version of the national currency, called a CBDC (Central Bank Digital Currency).
The use of CBDCs is something other Central Banks have already been studying, as it could allow each citizen to have direct custody of their money through a digital wallet, effectively revolutionizing the way money is kept today. We signaled this and other innovations enabled by DLT in our full report.
We delivered our full report on November 2018 and presented our product at the Central Bank’s headquarters on March 27th, which you can watch here in Portuguese. Since then, we have been keeping our ear to the ground for new developments and announcements regarding the Brazilian Fast Payments ecosystem, while also working closely with established payment companies to help them prepare for the oncoming changes.
If your company needs guidance on Fast Payments, or has interest in exploring the benefits of DLT, we would love to help you. Reach out to us at contact@swipetech.io.
